BRUSSELS 9 November 2017. Today, the European Parliament, the EU Member States and the Commission reached a provisional agreement on the reform of the EU Emissions Trading System (EU ETS) for the 2021-2030 period. The deal falls far short of meeting the Paris climate goals, pointing to the need for additional action at national and EU level.

Key elements of the decision adopted today relate to the speed of required reductions, the number of free pollution permits given to industry installations and to energy producers, and the use of revenues from auctioned permits.

The policy makers adopted an emission reduction trajectory of 2.2% per year which is too slow to reach the EU’s 2050 climate objectives.

In a positive move towards a higher carbon price, they did agree to annually cancel excess emission allowances from 2023 onwards which could lead to a cancellation of up to three billion allowances by 2030. However, pollution prices are expected to stay far below what leading economists say is needed to trigger the required clean investment flows.

Femke de Jong, EU policy director said:

“Today’s deal ignores the urgency to reduce emissions quickly and hands out billions in pollution subsidies, meaning that the EU carbon market will continue to fail at its task to spur green investments and phase out coal. Now individual governments must show climate leadership by pricing carbon nationally at levels that are high enough to avert dangerous climate change.”

There is growing momentum for carbon floor prices in Europe: Following UK precedent, the new Dutch government has announced a rising carbon floor price for its electricity sector, reaching EUR 43 by 2030. Portugal will implement a new tax on coal fired electricity generation and French President Macron has also called for a ‘significant minimum carbon price’ to boost investments in the energy transition.

No end to fossil fuel subsidies from the EU’s carbon market

The derogation known as article 10c under which free emission permits can be given to energy producers in lower income member states will continue after 2020. So far, the provision has been misused with 86% of free allowances issued to lignite and hard coal plants representing coal subsidies of up to 12 billion euros by 2020.

The parties failed to adopt robust rules that would avoid such coal subsidies under Article 10c in the next decade. After pressure from environmental groups, they did agree to exclude funding for coal under the new Modernisation Fund (with an exception for the two poorest countries Bulgaria and Romania).

Femke de Jong:

“Policymakers left the door open for billions of EU ETS money to be potentially used on ageing coal power plants, which not only violates the spirit of the Paris Agreement but also puts lives at risk by fuelling the air pollution crisis. The EU’s flagship climate tool should drive a phase out of coal and boost investments in clean energy sources, while supporting communities and workers in the low-carbon transition.”

Billions in industrial pollution handouts

Heavy industry is set to receive free pollution permits worth up to EUR 170 billion over the next decade under the revised ‘carbon leakage’ rules. So far, the excessively generous handout of free permits has resulted in over 25 billion euros windfall profits and a standstill of industrial emissions for the past five years with no foreseen emission cuts in the coming decade.

Femke de Jong concluded:

“The reform process has failed to make the EU ETS a viable instrument to decarbonise European industry. Eyes are now on the European Commission that needs to put forward a strategy to bring Europe’s industry at the forefront of the global low-carbon transition to guarantee its long-term competitiveness.”

The compromise also foresees an Innovation Fund to be established to incentivise the development of new low-carbon technologies. It will be financed through auctioning at least 450 million allowances, corresponding to over 11 billion euros throughout the next phase. While a step in the right direction, the size of the fund will be less than a tenth of the total pollution subsidies in the form of free allowances to heavy industry.

Today’s agreement will need to be formally approved by both the European Parliament and the Council before it enters into force.-ENDS-

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The EU ETS is Europe’s main tool for driving emission reductions in the power and industrial sectors but suffers from a huge surplus of pollution permits which has lowered the price, therefore failing to incentivise climate action in the covered sectors.

The provisional agreement contains the following elements:

Ambition
The pace at which emissions are reduced annually, the Linear Reduction Factor (LRF) will be raised from the current 1,74% to 2,2% from 2021 onwards. A linear reduction factor of at least 4,2% would be needed in order to bring the EU ETS in line with the 1.5°C goal.

Market surplus
The temporary storage for excess allowances, the Market Stability Reserve, will take in 24% of the surplus a year until 2023 i.e. double the previously agreed percentage. Furthermore, the permits in the reserve exceeding the previous year’s auctioning volume will be cancelled annually starting in 2023. Member States will moreover be allowed to cancel emission allowances associated with the retirement of power plants, so these allowances cannot be used to increase emissions elsewhere or in the future.

Free allocation under ‘carbon leakage’ rules
The parties decided to make available an additional up to 3% free allowances through the lowering of the auctioning share which means that industry will receive a total of up to 6.8 billion free pollution permits between 2021 and 2030.

As part of the EU ETS review, the Commission will assess whether the current carbon leakage provisions need to be replaced by carbon border measures in the future – a proposal that President Macron recently advocated for as well.

A push by the steel industry to receive over-compensation for its waste gases was rejected by the negotiators in the final deal. Instead, free allocation to hot metal will be reduced by a mere 0.2% each year until 2025, which means the steel sector will receive hardly any incentive for reducing emissions in the coming years.

Funds
An innovation fund financed through the auctioning of at least 450 million allowances will be used to incentivise the development of new, low carbon technologies.

Lower income countries can continue to give free allowances to their energy sector under the derogation known as the article 10c equal to 60% of their auctioning volumes. Due to a lack of robust selection criteria and public participation processes, the countries have so far largely abused this provision to fund coal-fired power plants.

A modernisation fund will be set up to support lower-income countries in modernising their energy systems. The fund will be financed through auctioning 2% of the total number of allowances and excludes coal investments except for the poorest Member States (Bulgaria and Romania) who are still able to use this fund for coal for district heating.

Prices
Hovering around 7 euros per tonne, the carbon price is currently not encouraging decarbonisation of industries. The reform is projected [paywall] to raise the price to around 20euros / tonne in 2025 and around 30 euros / tonne in 2030. It is estimated that the price would have to be at least 40 euros / tonne rising to 100 euros / tonne by 2030 to have the desired effect.